Oil’s Trouble Spots

With oil supplies tight, regions most vulnerable to oil supply disruptions present a significant economic concern, particularly threats to the Strait of Hormuz and unrest in Nigeria, explains this Backgrounder.

Introduction

At a time of rising dependence on oil, the potential for supply disruptions and the stability of energy-rich regions pose major concerns. While disruptions can happen anywhere along the supply chain, certain areas are particularly vulnerable. Perhaps the best known of these is the Strait of Hormuz in the Persian Gulf, through which tankers carry 20 percent of the world’s oil. In late 2011, the strait was threatened with closure by Iran in response to ramped up Western sanctions related to its nuclear program. Libya unexpectedly experienced a major supply disruption in 2011, after an armed uprising that eventually ousted former leader Muammar al-Qaddafi. The Niger Delta and Venezuela remain vulnerable as well. With global supplies of oil already tight, potential supply disruptions could lead to significant increases in already volatile oil prices.

When Oil Doesn’t Flow

Since the oil embargo of the 1970s, a number of countries have set up plans to mitigate the impact of a supply disruption. Some have their own strategic reserves to protect against short-term oil shortages. The International Energy Agency, a membership organization to address energy issues, also coordinates national reserves among twenty-seven member countries including the United States to share oil reserves during emergencies. In 2011, after Libya’s oil output dropped from nearly 1.6 million barrels per day (bpd) to just 100,000 bpd (Reuters), IEA countries agreed to a coordinated short-term release from their strategic oil reserves to ease the impact on global oil supplies.

Supply disruptions, or fear of such, are due to everything from political instability and terrorism to the weather and a lack of long-term investment, says Sarah O. Ladislaw, an energy fellow at the Center for Strategic and International Studies. Accidents can disrupt oil supplies, as can a lack of reinvestment of oil revenues into infrastructure, a problem some experts say is exacerbated by the rise in resource nationalism. Ladislaw saysthe best ways to protect against disruptions are to diversify supplies and suppliers, to ensure the economy is running efficiently, and to carefully manage geopolitical relationships.

Energy Trouble Spots

Major oil and gas production exists in some of the world’s most volatile regions. Here is a look at some that generate the most concern:

• Strait of Hormuz. The strait--the waterway that leads from the Persian Gulf into the Arabian Sea--is just twenty-one miles wide at its narrowest and is considered the world’s most worrisome chokepoint. It is a vital shipping route for some of the world’s biggest oil producing nations, including Saudi Arabia, Iraq, Kuwait, Oman, and Iran. The Gulf region holds more than 60 percent of the world’s proven oil reserves and as much as 40 percent of the world’s proven natural gas reserves. In 2011, about 17 million bpd flowed through the strait, representing about 35 percent of the world’s ocean oil shipments, according to the U.S. Energy Information Administration.

One of the biggest perils to strait traffic continues to be a longstanding threat by the Iranian government to blockade oil shipments should its nuclear facilities be attacked. Iran’s threat was renewed in 2011 following a new set of economic sanctions imposed by Western countries as a lever to try to stop its nuclear program, which is a suspected cover for building nuclear weapons.

Some analysts say that although Iran does not have the military might for a full-blown blockade (Stratfor), it could disrupt traffic significantly and raise oil prices. The U.S. military says it has the capabilities to prevent a blockade. However, some experts say closing the strait even for two weeks would have significant global economic consequences. Some analysts say a disruption could also raise oil prices by as much as $50 a barrel within days (NYT) andprecipitate major revenue losses for Gulf countries that rely on oil wealth.

About 4.5 million bpd (Reuters) could reach the global oil market by alternative pipeline routes, though the EIA notes that such measures would be slower and costlier. The International Energy Agency has said it was ready to step in with strategic reserves, similar to the situation in Libya, but has not said how much oil (FuelFix) it would release. Some reports say it could be as much as 14 million bpd.

• Iran. As the world’s third-biggest oil exporter behind Russia and Saudi Arabia, Iran ships about 2.5 million barrels per day, the bulk going to Asia. In addition to issues related to the Strait of Hormuz, the use of international sanctions against Iran or a military confrontation (ForeignAffairs) over its nuclear activities are significant oil disruption concerns. In early 2012, the United States placed unilateral sanctions on any financial institutions that do business with Iran’s central bank. The EU is also considering an embargo on oil shipments, which represents about 17 percent of Iranian oil trade (RFE/RL). If implemented, both moves could considerably hit oil revenue, which comprises more than half the Iranian government’s revenue.

Although some analysts believe Iran will still find buyers for its oil—though likely at a discount, other analysts note that a loss in Iranian exports of 1 million bpd would need to be made up through increasing Saudi output and potentially tapping oil reserves (Reuters) as was discussed when Libya’s output fell in early 2011. However, they also note such measures would make it difficult to weather other oil emergencies. In a January 2012 paper, energy expert Philip K. Verleger said the United States should sell oil from the U.S. Strategic Petroleum Reserve to help U.S. allies cope with the loss of Iranian oil imports and ease the potential pressure on oil prices.

One of the biggest perils to traffic in the Strait of Hormuz continues to be a longstanding threat by the Iranian government to blockade oil shipments should its nuclear facilities be attacked.

Sanctions also hurt the country’s long-term output.Projections suggest output could decline by nearly 1 billion bpd in the next few years without new investment (NYT).In 2008 during increasing tensions, the head of OPEC warned (AP) that the cartel would not be able to make up the difference in a loss of output from Iran, which represents about 10 percent of OPEC’s production.

• Niger Delta. Nigeria is the second-largest oil producer in Africa and the fifth-largest oil supplier to the United States. Due to a rise in civil strife, it dropped from being the world’s eighth-largest producer to its twelfth-largest between 2006 and 2008. In 2009, Nigeria’s government reconciled with militants in the Niger Delta, who had been significantly disrupting oil production by attacking workers and oil facilities as well as stealing oil. But a resurgence of violence is still possible. Nigeria in early 2012 also faced a nationwide strike after the government declared an end to fuel subsidies. Such a strike could impede oil production.

The distribution of oil wealth is a central factor in the conflict. Despite its vast oil wealth, 70 percent of Nigeria’s population lives on less than a dollar a day and government corruption, especially at the state level, remains a problem. Oil companies must also contend with the large-scale stealing of crude oil, in which powerful politicians and senior military officials are implicated.

• Libya. The country dropped output to near 100,000 bpd during its conflict to oust former leader Muammar al-Qaddafi and by early 2012, was producing 840,000 bpd, about half of its pre-conflict production levels (BBC). Libyan officials hope to return to full production by the end of 2012, but the political situation remains in flux.

• Venezuela. The rise of energy wealth has brought with it increased resource nationalism in major Latin American oil producers such as Venezuela, Bolivia, and Ecuador. In the past several years, these states have renegotiated contracts with international oil companies to give state-run oil companies a controlling interest. Venezuela, the world’s ninth-largest producer of oil, has taken over some projects entirely.It supplies about 1 million bpd of oil to the United States. The United States has also placed limited sanctions on Venezuela’s state-run oil firm PDVSA for doing business with Iran (CNBC). And President Hugo Chavez has threatened to cut off exports in several diplomatic disputes.

Some experts worry that Venezuela is not investing enough in oil exploration and infrastructure and instead using oil money to fund other government priorities. PDVSA, which reportedly earned more than $88 billion in 2011, spent $15 billion on social programs in the first six months of the year and transferred at least another $14 billion to the country’s central bank.Experts also worry that reduced investment by nationalized firms in new oil and gas infrastructure will lead to production declines over time as maturing wells are not replaced by new exploration.

• Iraq. It has the third-largest proven oil reserves in the world, but Iraq’s oil production has not returned to the levels of the early 1990s, before the first of two wars against the United States, when output was slightly less than 3 million bpd. Since the 2003 war began, oil infrastructure has been a target for insurgent attacks and has yet to recover from fifteen years of decline. Iraq has steadily improved output, and exports are expected to increase from 2.2 million bpd to 2.6 million bpd (BusinessWeek) by the end of 2013. However, oil infrastructure remains a target of attacks and political stability is tenuous, particularly with the exit of U.S. troops at the end of 2011.

• Russian and Caucasus Pipelines. In the last decade, Russia has emerged as an energy superpower. Russia is the world’s second-largest oil producer and the world’s biggest producer of natural gas. Other states in the region, including Kazakhstan and Azerbaijan, also have emerged as significant producers with massive reserves of oil and natural gas. This energy wealth has troubled the Kremlin’s relations with some former Soviet states, including Georgia, Belarus, Turkmenistan, and Ukraine. For instance, 80 percent of Russian gas (BNet) is routed through Ukraine. At the end of 2008, relations further soured over discussions about prices for gas shipments to Ukraine and pipeline transit fees for gas flowing through Ukraine. In the first days of 2009, Russia’s state-controlled energy company, Gazprom, cut off natural gas shipments to Ukraine. Ukrainian officials in turn blocked shipments of gas from Russia into other parts of Europe.

There are a number of plans to bypass the Russian pipeline network including linking Kazakhstan to the Baku Tbilisi Ceyhan (BTC) pipeline, which runs through Georgia from Azerbaijan into Turkey and can carry more than one million barrels of oil per day. In late 2011, Russia sought to block the trans-Caspian pipeline that would carry Turkmenistan gas to the Nabucco pipeline, another system bypassing Russia.Such plans come at a time when Russian pipelines operate at near capacity and some are deteriorating with age. Beyond Russia, analysts also note that the region has historically been a source of ethnic and political conflicts that could disrupt the flow of oil and gas.

• Gulf of Mexico. The United States is one of the largest oil and gas producers in the world. A significant portion of the nation’s production infrastructure--30 percent of oil production and more than 20 percent of gas production--sits in the Gulf of Mexico, a region of frequent major hurricanes. The Louisiana Offshore Oil Port (LOOP) is also the nation’s biggest oil import terminal. Following Hurricanes Katrina and Rita in 2005, the country experienced a supply disruption of about 8 percent. The storm caused a jump in crude prices that was somewhat eased by a release of oil from emergency petroleum reserves.

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